Asia high yield could benefit from US protectionism
Any US protectionist action against Asia could have only a brief negative impact on investor sentiment in the region’s corporate bond market, according to Matthews Asia.
This means Asia high-yield debt may represent a good investment opportunity right now as capital continues to flow into the region, notably into the emerging markets of India, Indonesia and Thailand, says Teresa Kong, Portfolio Manager at Matthews Asia.
A scaled-back US economic engagement with Asia might not result in a vacuum in trade or foreign direct investment. Instead, it would leave more room for companies from China, India and Japan to pursue their ambitions and thereby help to maintain a good level of economic activity, Kong says.
Historically, investing in high-yield Asia credit where spreads are today (at 455 basis points) has provided positive returns over a three-year holding period, supported by the region’s strong economic fundamentals and improved corporate governance.
Past data indicate that the asset class has also generated higher returns with similar or even lower volatility than US, European and Latin American high-yield bonds. Matthews Asia, which manages around US$28 billion in assets as of 30 April 2017, also expects default rates to fall from last year as commodity prices recover.
Asia also offers good-quality companies. The ratings of some of the best-run companies in the region are limited by the country’s sovereign rating, says Kong.
“There are many examples of corporates that have been constrained in ratings by their zip code,” she explains. “The very best bank in India, for example, can only get a BBB- rating because the Indian sovereign’s BBB- rating acts as a ceiling for corporates.”
As Asian currencies trade near their lowest levels in 10 years against the US dollar, current valuations also offer an attractive entry point to the region’s markets.
“We think the USD is overvalued and most Asian currencies have room to appreciate relative to it,” Kong says. The dollar is expected to strengthen further in the short term as the Federal Reserve continues to pursue monetary tightening.
While many factors contribute to a company’s business performance against its peers, those that have consistently done well generally have the appropriate combination of financial and operating leverage, Kong says.
“High operating leverage and very high financial leverage is typically a formula for disaster, because it means that the company hasn’t allowed enough cushion to weather the storm in a downturn,” she notes.
Understanding different accounting rules and the region’s bankruptcy laws is crucial when analysing Asian debt. “With expertise in the accounting standards of specific countries and knowledge of differences in bankruptcy codes, we can usually discern value,” notes Kong.
Different countries, for instance, allow different ways of recognising cash. “Typically, you would think of cash as spot-dated securities that mature within 365 days and are practically risk-free,” she says. “But in some countries, such as China, wealth management products have a cash component that is not necessarily principal- protected and some of them are not real cash equivalents.”
Asian companies’ management structures also differ from those in developed western markets. “In some companies, the decision maker may not be the CEO, and there are occasions when the chairman of the holding group has a greater influence on the running of the business,” Kong says.
Looking forward, she is positive on India and Indonesia. At a policy level, these countries have controlled inflation and managed investor expectations.
“If you look at the long-term story, Indonesia is really in a sweet spot both demographically and from a per capita GDP point of view,” Kong says. “With S&P having revised its rating for Indonesia [to investment-grade], we expect Indonesian corporates to attract more investors,” she adds.
Despite uncertainty over US trade policy regarding emerging markets, the outlook for Asian high yield looks more favourable than the backdrop may suggest.
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